Working Paper: CEPR ID: DP1863
Authors: Tito Cordelia; Isabel Grilo
Abstract: In this paper, we adopt the vertical differentiation duopoly framework to give a full description of firms? relocation decisions, when the removal either of trade barriers or of restrictions on capital outflows/inflows (?globalization?) allows them to serve the domestic market through foreign plants. We identify the advantages associated with production abroad with the possibility of exploiting a given wage differential. We show that when the liberalization of trade or investment flows yields the relocation of the whole industry, autarchy is strictly better, in welfare terms, than ?globalization?. It is only when relocation is a dominant strategy for one (and only one) of the firms, that ?globalization? may be unambiguously welfare improving. Furthermore, we show that the effects of the relocation of the high or of the low quality firm are different. In particular, if the economy is ?high quality biased? (?low quality biased?) the relocation of the firm producing the high quality variant (the low quality variant) is preferred, in welfare terms, to the relocation of the other firm, if the wage differential is high enough.
Keywords: production; relocation; vertical differentiation; Bertrand competition; globalization
JEL Codes: F02; F12; F23; J60; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| globalization (F60) | firms' relocation decisions (R30) |
| wage differentials (J31) | firms' relocation decisions (R30) |
| firms' relocation decisions (R30) | domestic welfare (I38) |
| globalization (F60) | domestic welfare (I38) |
| high-quality firm relocation (R30) | domestic welfare (I38) |
| low-quality firm relocation (R30) | domestic welfare (I38) |
| foreign wage (J31) | social cost of relocation (R23) |
| efficiency gains from relocation (J62) | unemployment costs for domestic workers (J65) |